This document decrees the division of retirement funds in a divorce
Reviewed by Pamela Rodriguez
What Is a Qualified Domestic Relations Order (QDRO)?
A qualified domestic relations order (QDRO) is a court decree that mandates how assets in a retirement plan or pension fund will be divided in a divorce. The QDRO may specify the amounts to be paid to a former spouse, child, or other dependent for child support, alimony, or marital property rights.
The recipient of money authorized by a QDRO must transfer it directly to another tax-advantaged retirement plan such as an individual retirement account (IRA). Otherwise, the entire amount will be taxable as income.
The terms of the QDRO must comply with the federal regulations in the Employee Retirement Income Security Act (ERISA) and the appropriate state’s domestic relations laws.
Key Takeaways
- A qualified domestic relations order (QDRO) is a court-approved document that specifies how money in retirement accounts will be split in the event of a divorce.
- The QDRO is used primarily to split assets held in tax-advantaged retirement accounts such as IRAs and 401(k)s.
- A former spouse receiving assets from a QDRO must transfer them directly into another tax-advantaged retirement plan or face a hefty income tax bill that year.
How a QDRO Works
Regardless of how most of a couple’s assets are divided, the QDRO defines how their retirement savings will be divided if the couple has money in a qualified plan such as a 401(k) or a 403(b). A separate process called “transfer incident to divorce” is used for IRAs.
A QDRO must comply with the Employee Retirement Income Security Act (ERISA) and the domestic relations laws within the state’s jurisdiction. ERISA was established by the U.S. Congress to provide a regulatory framework for employer-sponsored retirement plans and ensure protections for beneficiaries and participants.
Who Is the Alternate Payee in a QDRO?
A QDRO grants the retirement account’s “alternate payee” the right to a portion of the retirement benefits that the former spouse (the “participant”) earned through an employer-sponsored retirement plan. The payee may be a spouse or a dependent.
A QDRO, for example, might order the payment of 50% of the account assets that accumulated over the years of the marriage. The funds could then be transferred or rolled over into an IRA for the beneficiary spouse.
A QDRO can assign funds to a child as child support payments. The beneficiary will be granted the funds and can have the money transferred to an existing or new retirement account in their name.
Survivors’ Rights
A QDRO benefits an alternate payee when the participant is alive but may also award survivor benefits if the participant dies.
How to Initiate a QDRO
The spouse who will be the alternate payee of the QDRO commonly contacts an attorney to draft a QDRO document that will order the funds to be transferred. Most plan administrators have standardized forms for this purpose. The drafted QDRO is submitted and, once accepted and approved by the plan administrator, is assigned to the court.
QDRO documents include the following information:
- Name and last known mailing address of the participant and alternate payee(s)
- Name of each retirement plan that the QDRO is designed to cover
- Dollar amount or percentage of the participant’s benefits to be paid to the alternate payee(s). The QDRO must state how the percentage or dollar amount was determined
- The time frame for which the QDRO applies, including the commencement date and the number of payments
- What happens in the event of the death of the participant and alternate payee
- What happens if the retirement plan is terminated
Benefits and Limitations of a QDRO
The QDRO ensures that one spouse doesn’t end up with no retirement funds in the event of a divorce.
The spouse making the payout is not subject to an early withdrawal penalty by the IRS for transferring the funds to the ex-spouse. Typically, the IRS charges a 10% tax penalty on any funds withdrawn from a tax-advantaged retirement account if the person is under age 59½.
The beneficiary receiving the funds is not taxed at the time of the transfer, as long as the money is transferred to a retirement account. If the funds are not paid into a retirement account, the money will be taxable. If the recipient is under age 59½, a 10% fine will be added.
Limitations to a QDRO
Assets will not be transferred under a QDRO if the money is already promised to another alternate payee via another QDRO.
Only benefits that the retirement plan administrator offers are included in the transfer of the assets.
Contributions that were made to a pension or retirement plan before the couple married are not included in the QDRO.
Warning
If the account holder has a loan against the 401(k), the QDRO must consider how it will affect the division. Otherwise, the beneficiary’s assigned amount may be reduced.
Taxes on QDRO Payments
The QDRO defines how the money is distributed and the percentage or dollar amount allocated to the ex-spouse.The ex-spouse could opt to receive a lump-sum payment for the percentage of assets in the plan.
However, if the lump sum is transferred into a non-IRA account, the beneficiary must pay income taxes on that distribution. A QDRO distribution paid to a dependent or child is taxed to the plan participant.
The beneficiary can receive the assets in installments. Another option is leaving the money in the spouse’s plan but retaining the right to invest the portion allotted to the alternate payee. The beneficiary must comply with IRS rules regarding retirement accounts following the transfer.
In retirement, distributions may be taxed based on the beneficiary’s income tax rate, and the beneficiary must comply with the required minimum distribution (RMD) rules.A spouse or former spouse who receives QDRO benefits from a retirement plan reports the payments received as if they were a plan participant.
A trustee-to-trustee transfer is typically the safest way to transfer retirement funds in a rollover from one retirement account to another. The funds move between two financial institutions: the participant’s retirement plan and the beneficiary’s retirement account. Neither individual touches the money, so the IRS doesn’t count it as a withdrawal.
Beneficiaries receiving retirement funds from a QDRO must consider those additional assets when calculating their required minimum distribution (RMD) in retirement.
Example of a QDRO
David and Kristen have been married for 15 years and have agreed to file for divorce. David currently has $200,000 in his 401(k) retirement plan, of which $50,000 was in the plan before their marriage.
During the divorce proceedings, both parties agreed on the assets to be divided, including the 401(k). The court-ordered QDRO was drafted by a divorce attorney and submitted to David’s retirement plan administrator. The plan administrator approved the QDRO, which has the following terms:
- David keeps the $50,000 that was in his 401(k) before the marriage.
- The remaining $150,000 in the 401(k) is split evenly between David and Kristen since those funds are considered a marital asset.
- Kristen can transfer $75,000 from David’s 401(k) into a separate retirement account in her name.
Can I Protect My Retirement Savings in a Divorce?
If the retirement account holder wants to hang onto the full amount in a pension or retirement plan, they could offer the ex-spouse an equal amount of other assets, such as a bigger share of the profits from a home sale.
Is a QDRO Required in a Divorce?
Federal law does not require that a QDRO be in place in the case of a divorce settlement. It is up to the parties involved to determine whether a QDRO should be drafted. A spouse with lower earnings or no earnings would have a strong incentive to make sure a QDRO is in place.
Are Distributions From a QDRO Taxable?
As long as the money from a retirement account is transferred to another tax-advantaged retirement account such as an IRA, the money will not be taxable at that time. The usual rules will apply. For instance, funds from a traditional IRA or Roth account will be subject to income tax when they are withdrawn after age 59 1/2.
Any money paid directly to the ex-spouse or other recipient will be taxable immediately. That means it must be transferred into a tax-advantaged retirement account.
The Bottom Line
A QDRO isn’t required as a part of a divorce proceeding, but it is a very good idea to put one in place. It ensures a fair split of the retirement savings accumulated during a marriage.
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